Monday, October 03, 2011

There Really is No Trade Imbalance to Eliminate, So Eliminating a Fictional Deficit Won't Create Jobs

What imbalance?

According to C. Fred Bergsten (Director of the Peterson Institute for International Economics) writing in the NY Times:

"The U.S. runs an annual trade deficit of about $600 billion, or 4 percent of our entire economy. Eliminating that imbalance would create three million to four million jobs, according to Commerce Department estimates, at no cost to the budget."

1. There really is no trade "imbalance" once we take into account the fact that an annual "trade deficit" of $600 billion is exactly offset by a "capital account surplus," "capital inflow," or "foreign investment surplus" of $600 billion. The chart above shows that America's annual "trade deficits" have been balanced every year with offsetting capital inflows, and since 1980 America has benefited by a cumulative $8.1 trillion "foreign investment surplus." Because there is no real "trade imbalance" to bring into balance, it's unlikely that any correction to a fictional imbalance would create any new jobs.

2. The only way to eliminate the $600 billion trade deficit would be to simultaneously eliminate the $600 billion foreign investment surplus. With the elimination of hundreds of billions of dollar of foreign investment that likely helps create jobs, why would we expect a net job increase?

As Don Boudreaux points out, if Americans purchase $1 million of Chinese textiles, that $1 million comes back into the U.S. either to purchase: a) $1 million worth of American goods and services, or b) $1 million of American assets (stocks, bonds, real estate, direct investment in U.S. firms, etc.).

Apparently, C. Fred Bergsten assumes that the $1 million spent on American goods supports or creates U.S. jobs, while the $1 million spent on U.S. assets does nothing for U.S. jobs. That's nonsense. The $1 million invested in the U.S. to purchase American assets might create more jobs in the long run than the $1 million spent on American goods. In any case, the simple fact that there is no "trade imbalance" to start with once we account for spending on both goods and financial assets, implies that eliminating a "fictional imbalance" won't have any effect at all on U.S. employment.

Update: In the study "The Trade-Balance Creed," Dan Griswold of the Cato Institute found the following historical relationship between trade deficits and jobs:

"Trade deficits are routinely blamed for job losses, yet civilian employment grew a healthy 1.4 percent annually during periods of rising trade deficits while job growth was virtually zero during those periods when the deficit was declining. Ditto for the unemployment rate. The jobless rate ticked down 0.4 percentage points per year on average when the trade deficit was on an upward trend, and jumped a painful 1.0 point per year when the trade deficit was shrinking. In four of the five periods in which imports did outpace exports, the unemployment rate fell, and in every period in which imports grew more slowly than exports, or fell more rapidly, the unemployment rate rose."

It's worth remembering that the first thing Lyman Gage did, as William McKinley's new Treasury Secretary, was impose a huge Import Tariff. Within 12 months we had shaken off the worst Depression up until that date - the Panic of 1893.

I'm not saying that high import tariffs are, necessarily, always the right thing; they aren't. But, as any successful punter will tell you, "there's different horses for different courses."

On This course we have a Powerful Trading "Partner" manipulating its currency, and putting our people out of work faster than we can retrain them.

Sometimes you just have to be Practical, and say, "enough is enough."

Theory is one thing; Massive Unemployment, and Depression is another."

Rufus: "It's worth remembering that the first thing Lyman Gage did, as William McKinley's new Treasury Secretary, was impose a huge Import Tariff. Within 12 months we had shaken off the worst Depression up until that date - the Panic of 1893."

Learn some economics.

"On This course we have a Powerful Trading "Partner" manipulating its currency, and putting our people out of work faster than we can retrain them."

It always amazes me that normally intelligent people cannot understand a simple identity! Of course, the question has to be what was the $600 million used for when invested in America? TO a certain extent even if most of it ended up as government bonds the money was still used by the government.

There is no doubt that it is more efficient to pay a American to do things for the U.S. government than it is for him to make toys (or Iphones...)

First, part of the reason why you have a huge trade deficit is because regulations discourage capital formation within the United States. Give the fact that capital formation is the foundation of a sound real economy this is a significant problem that you are not dealing with by just looking at the symptom.

Second, the surplus funds earned by foreigners are recycled in the treasury markets. The recycled cash is used to finance more spending by the government, which is crowding out and distorting the private sector economy. As time passes the private economy becomes more and more dependent on unsustainable policies that have to end when the consequences of reality become too large for the political players inside the beltway to deal with. (For example, it is good to talk about green jobs created by huge subsidies and loan guarantees. But when the markets intervene the companies are unable to compete even with their access to cheap credit and product subsidies. They close down and those green jobs disappear.)

Third, the recycled deficits are encouraging reckless behaviour not only in the corporate sector but among individuals. People who have access to unemployment benefits do not see the need to take low paying jobs that would help them transition to new careers. Instead of doing all that they can to acquire new skills they let their old ones deteriorate. In the end they have few marketable skills and a dependence on handouts that cannot be sustained.

Fourth, the recycled trade deficits permit the government to engage in foreign adventures that distort domestic production and the allocation of resources. The US does not need to finance an empire. If it had to pay its bills as other nations do, it certainly would not be engaged in more than half a dozen conflicts and have military bases in more than 100 countries around the globe.

Your argument is fine on some levels but it avoids the real issues that are material to your future prosperity. I think that you better take a step back and see things as they really are rather than what you think that they are.

"As Don Boudreaux points out, if Americans purchase $1 million of Chinese textiles, that $1 million comes back into the U.S. either to purchase: a) $1 million worth of American goods and services, or b) $1 million of American assets (stocks, bonds, real estate, direct investment in U.S. firms, etc.)."

Don didn't neglect those possibilities. He directly addressed those arguments at Cafe Hayek.

If China uses dollars to buy any non-U.S. asset, the third party seller of those assets must then do something with those dolalrs. It doesn't matter how many times the dollars change hands, they eventually must come back to the U.S. In the real world, that happens very quickly. No one is going to hoard currency when there are opportunities to earn a return by investing them.

I think Don did not "consider" the other two possibilities in his first post for a simple reason. He likely assumed that readers of an economics blog understood how dollars used in foreign trade are always returned to the U.S.

" It doesn't matter how many times the dollars change hands, they eventually must come back to the U.S. In the real world, that happens very quickly. No one is going to hoard currency when there are opportunities to earn a return by investing them."

Mr. Beagle,

Please cite a source of how quickly dollars return to the U.S., after they leave China as a non-U.S. purchase or non-U.S. investment.

Buddy: "OK, logic says that dollars are eventually repatriated but the path could be circuitous, long and not necessarily from China to settle their trade balance with the U.S. Am I wrong?

You are absolutely right, but why do you care? As long as they are gone, you have not paid for the textiles in the Boudreaux example.

If you buy groceries and give the grocer a note promising to wash his car in exchange, it doesn't matter what he does with it, or how he exchanges it further, until it is returned to you, you don't have to wash a car.

"If you buy groceries and give the grocer a note promising to wash his car in exchange, it doesn't matter what he does with it, or how he exchanges it further, until it is returned to you, you don't have to wash a car."

No, I have given the grocer a gift card. The grocer told me that he would exchange the gift card for my patented mouth wash. The grocer bought the mouth wash from someone else.

"a. I had to work to be able to load that gift card with value -- value that can be exchanged for goods and services.

b. The mouthwash is sitting in my iventory and I'm losing money from lack of sales."

Come on Buddy, put on your economics hat.

a. You manufactured mouthwash to charge that card with value. You gave it to your grocer instead of the mouthwash in exchange for groceries. You have the groceries AND you still have the mouthwash. You can go on as before, making and selling mouthwash.

You haven't yet paid for the groceries, as you would have if the grocer demanded mouthwash at the time of exchange. You have given the grocer an IOU - a gift card - promising to pay when he presents the IOU to you at a later time. This represents a free loan to you. If he loses or destroys the gift card, the groceries are free.

b. You have already been paid for that mouthwash that's sitting in inventory. If that's a problem, sell it and honor the gift card out of current production when it's presented.

Losing money on sales has nothing to do with the gift card. You have already been paid for an amount of mouthwash, that you still haven't delivered.

Do you think sales would be better if the grocer demanded the mouthwash he has already paid for?

And, it's possible the grocer could decide that fixing his car is more important right now than mouthwash, so he pays the mechanic with the gift card, who buys shoes from the cobbler with it, (do they even exist anymore?) who pays the rent to his landlord with it, who has foul breath, and comes to you for the mouthwash you owe, in exchange for the giftcard.

Hey Ron, if you are still reading this thread (getting old) then I'll wind up now.

I conclude that the basic symmetry of dollars out -> dollars in has a monstrous time warp that goes along with it. This time warp, along with dollars traded outside the U.S., has caused major distortions for the economy.

U.S. trade deficits, in the amounts of the last decade, have enabled surplus economies to work the U.S. dollar in the trading system for maximum advantage in non-U.S. purchases. The price paid for citizens of the U.S. economy, in a major way, is economic stagnation - along with gov't fiscal deficits.